1 The Development Impact of Small and Medium Enterprises: Lessons Learned from SEAF Investments VOLUME II: CASE STUDIES
2 Acknowledgements SEAF gratefully acknowledges the Department for International Development of the United Kingdom, the Ford Foundation of the United States, and the State Secretariat for Economic Affairs of Switzerland, which provided grants to make the study possible. Special thanks are due to all SEAF investors who have provided resources to SEAF s funds to invest in some 210 companies worldwide. Their continuous support has enabled SEAF to carry out its commercial and developmental mission. This report has prepared by a team of staff from SEAF headquarters in Washington DC and SEAF country offices for the relevant case studies. The team consists of MinhChau Nguyen (leader), Genta Arovas, Davis Broach, Hector Cateriano, Lyubomira Buresch, Peter Righi, and Nam Pham (consultant). Professor Stephen Smith from George Washington University in Washington DC provided SEAF with the conceptual framework on facilitating and assessing the poverty alleviation impacts of SME assistance, and worked with SEAF staff on one of the field trips to Peru. The authors gratefully acknowledge the support from Bert van der Vaart and Mildred Callear who have guided the team in preparing the report. Special thanks are due also to our research team: Rachel Rochat, Sondra Albert, and Sam Sezak, and our editor: Rachel Weaving.
3 Table of Contents Artima (Supermarket Chain, Romania) 1 Fideos Coronilla (Organic and Gluten-Free Pasta and Snack Producer, Bolivia) 10 Ken-4 (Meat Processor, Bulgaria) 16 Molino (Grain Mill, Peru) 24 PPZP (Pig Farm, Poland) 30 Printop (Industrial Ink Producer, Peru) 39 Symbio (Organic Produce Distributor, Poland) 45 Tambo Inca (Flour Mill, Peru) 55 Telezimex (Electronic Components Distributor, Romania) 63 Victoria Classics (High-End Clothing Manufacturer, Peru) 70 The financial rates of return and economic rates of return for the companies profiled are based on the actual financial statements of the companies, the companies projected figures for the future years, interviews with company employees and other stakeholders, and publicly available economic and financial data. Company financial statements are the responsibility of company management. SEAF works with company management to improve the integrity of financial reporting. Select companies have annual IAS or local audits. Where audits are performed, data is adjusted as necessary to conform to audited results. In cases where the companies did not have projections, SEAF staff did their best to project the data needed for the model based on their knowledge and data availability from the past performance. SEAF and its representatives expressly disclaim any representations or warranties, expressed or implied, as to the accuracy of the future results. Past performance may not be indicative of future performance. See Volume I, Main Report, for more information on the methodology used for the case studies, as well as an analysis of the aggregate results. Prepared August 2004 by the Small Enterprise Assistance Funds, Washington, D.C.
4 Romania Artima Introduction Artima Retail Investment Company (Artima) owns and operates supermarkets in the Banat and Transylvania regions of northwestern Romania. These regions contain approximately 50 percent of Romania s total population of 22 million. Although Artima s headquarter offices are located in Timisoara, one of the primary cities in the region, its current nine supermarkets are located in secondary cities with population sizes between 50 and 200,000. These towns and cities are without many of the conveniences of the more modern cities in Romania, while Bucharest and other major cities in Romania are rapidly joining Europe s level of development. The total market for fast moving consumer goods (FMCG) in Romania is approximately 5.5 billion, with modern retailers making up only 11 percent of this market. Artima began its operations in 2001 with approximately US$ 2 million in invested capital. During the first year Mr. Banu (the main owner) and his partners opened three supermarkets, achieving 1.88 million in revenue. In 2002, the Romanian fund managed by SEAF, the Trans-Balkan Romania Fund (TBRF), invested US$ 650,000 in Artima. Artima opened three more stores. In 2003, Artima opened an additional three stores financed by the investment from the Growth Fund (also managed by SEAF), and a follow-on investment by the TBRF. To date, Artima has built nine supermarkets in the following cities: Location Pop. Date Opened Resita 93,000 Oct Lugoj 49,000 Nov Deva 76,000 Nov Sannicolaul* 38,000 Jun Caransebes* 41,000 Aug Oradea 220,000 Nov Bistrita 100,000 Jun Baie Mare 200,000 Nov Petrosani 60,000 Dec Total: 517,000 - * Includes population in nearby areas. Lugoj Supermarket All locations are considered to be at the most convenient locations in their respective towns, given their central location and the amount of foot traffic. For example, in Resita the supermarket is built in the most densely populated part of the city and in Lugoj it is built in the center of the town, and in Deva the location has been leased on the ground floor of Ulpia Commercial Center (in the very the center of the city) for 25 years. Artima has been able to obtain these premium locations with relatively attractive conditions largely due to the lack of any other significant economic activity in these cities and Artima s willingness to finance infrastructure improvements as part of its investment. Artima s investment objective is to become the first (and most strategically located) supermarket in secondary cities in the Transylvanian and Banat regions. The level of economic activity and development in these cities is generally large enough to support a supermarket with 800 square meters of selling space and approximately 5,000 stocking units (SKUs) but too small to support another supermarket. Provided 1
5 that the store locations are run efficiently, the investment thesis is that a larger international or domestic chain will ultimately purchase these locations at a good return for the Fund s investors. Development Impacts The quantified results of SEAF s development impact analysis are presented below Statistical Revenues in 2003 (US$) 18,358,746 Gross margin (%) 19 Net margin (%) - 1 No. of employees 271 % of low - skilled workers 39 Avg. wage for low - skilled (US$) 77/m SEAF investment to date (US$) 3,096,525 Realized proceed s to SEAF (US$) 106,188 Realized and unrealized (US$) 3,973,353 Multiple of capital invested 1.28 Financial & Economic Financial rate of return (%) Economic rate of return (%) Benefit/cost rat io (0% discount) Benefit/cost ratio (10% discount) 12 a 122 b 6.81 c 3.94 c a return to the company b return to society c additional dollars generated for society from every dollar invested in the company in constant terms The sections below describe the impacts on each stakeholder, which were quantified to reach the above. Private Returns The Artima investment plan calls for significant investment over four years in fixed assets as the supermarket chain establishes its potential market share growth, several years of organic growth where Artima increases its market share and operational efficiency to steadily increase cash flows, and finally a terminal value for the shareholders when the business is sold to a strategic buyer. Artima has rapidly grown from US$ 2 million in revenue in 2001 to approximately US$ 18 million in As the company grew and obtained larger buying power, gross margins have gradually increased from approximately 16 to 19 percent. Although unprofitable in the first two years of operation, Artima s increasing capital base has resulted in net cash profitability in Artima s success factors among its clientele are the location of the supermarkets, the range of products it made available, the quality of the goods on offer, and the modern retail experience that was previously non-existent. While SEAF s investments in Artima are still less than two years old, SEAF believes that the financial rate of return to its investors will be substantial. There have already been three strategic parties who have approached Artima with an interest in purchasing the company. 2
6 Impacts on Labor Artima s impact on labor is quite significant due to both the number of employees hired and the level of training they receive. As an example, each supermarket requires approximately 50 employees, 15 of which are unskilled. The remaining 35 employees are considered skilled or semi-skilled, not necessarily based on their previous job history, but due to the training and skills that are required on the job. This training is critical to Artima as the skills required for the jobs do not exist on the market. As an example, of the approximately 50 employees hired per store, about 35 are sent for one to three weeks of training at another Artima store to learn retail skills such as cashier management, product outlay and display, and inventory control. Skills necessary in the butchery and bakery departments, for example, may exist on the market, but have to be upgraded in order to comply with Artima s standards and industry best practices. Artima is therefore responsible for a significant amount of training, in addition to the simple hiring of employees. Employment Since its start up in 2001, employment in 2002 reached 568 people. Direct personnel costs were eight percent of revenue, about twice the industry average in a market where salaries are generally low. Due to the complexity of Artima s business and the need for a sizeable headquarters presence to prepare for the scaling up of the business, the first few years of operations have required a 60/40 split of skilled to unskilled employees. Due to economies of scale at headquarters, once the network is fully built out, growth of unskilled labor versus growth in skilled labor should grow at a ratio of two to one. Wages Artima s wages for its skilled labor, on average 2,100 per annum, are roughly at or near the average skilled wage in the economy, while its unskilled labor wages began above the minimum wage and are trending downwards toward equilibrium. Therefore, beyond , SEAF is not counting any direct salary contributions to the measured total development, economic or financial impact. However, because Artima, unlike many of its competitors, operates in the official economy, it pays the necessary taxes associated with employment in Romania. Black market operators which in Romania represent the bulk of the food-retailing sector avoid the taxes. A table of these taxes follows below. Personnel Taxes: Levies on the employer: 24.5% Social Insurance 3.5% Unemployment Funds 0.75% Working Book 7.0% Health Insurance 0.5% Risk Funds 36.25% Total Levies on the employee: 9.5% Social Insurance 6.5% Health Insurance 1.0% Unemployment Funds 17.0% Total Quantifiable Non-Salary Benefits Although wages for all employees are held at or near the market standard at Artima, there are a multitude of non-salary benefits paid to employees on a regular basis. These non-salary benefits are generally employed throughout Eastern Europe in order to increase the employees monthly current income without incurring even higher pension and health contribution liabilities to the government by the employee or 3
7 company. At Artima these benefits include 30 meal tickets per employee per month and at-work meals for all employees, travel allowances, apartment rent, and cash bonuses based on performance at the management level, which can equal up to three times the monthly wage. On average these benefits total an additional 1,200 per employee premium and constitute the total quantifiable non-salary input to the economic impact for purposes of the developmental impact study. 1 Artima has pioneered a performance incentive scheme, previously untried and unfamiliar in the context of the local labor market, where wages previously were never tied to performance. The structure encourages managers to focus on money-saving and money-earning aspects of store performance by sharing a portion of the savings with the manager. The scheme has the potential to be applied at the operational store level for specific tasks, although it is at present too unfamiliar to be introduced to the total labor force at Artima. The basic parameters of the scheme are as follows: Monthly Performance Measurement Store Level Value ( ) Base Salary 200 Revenue meets turnover target 50 OPEX held within 4% of turnover 200 Theft and shrinkage rates below 1% of turnover 100 Inventory revolves less than 21 days 50 Out of stock % held at target minimums 200 Total Potential Wages 800 Training Prior to their employment by Artima, skilled managers were generally either self-employed entrepreneurs or worked at the management level in a large company that was closed under privatization, while unskilled labor and skilled labor below the managerial level were previously employed in small shops or on the black market at below the minimum wage. Regardless of their background or level, each and every employee has undergone intensive training, as modern retail is virtually unknown in the cities where Artima builds its supermarkets. According to one store manager (verified by others), training is generally split into three categories: work culture, professional environment, and retail skills. Hiring decisions are based on the employee s willingness to be a productive employee and determination. Because of the work culture created under a state-controlled economy and the contraction in the Romanian economy since then, everyone goes through training on work culture and expectations, as well as how to manage working in a professional environment where productive teamwork is crucial. Training for skilled employees generally takes one to three weeks on-site at another store location, while store managers require up to three months of intensive training. Besides the elements of work culture and professional environment and other retail skills that are taught less formally on the job, skilled employees work with their counterparts at other store locations to develop the necessary skills in cash management, inventory control, the information technology system (which tracks the flow of goods from warehouse receipt to point-of-sale), and theft control. Store managers are trained in the above areas in greater depth, as well as skills in personnel management, performance measurement and tracking, and budgeting, among others. Training continues on a monthly basis to go over new procedures and/or retail trends. In addition, store managers conduct their own training programs at the store level through weekly meetings with the chiefs of each department. These costs are accounted for through the opportunity costs of the employees wages and are included in the quantified developmental impact analysis. 1 Quantifiable non-salary benefits are annualized for total employment during store expansion years and do not necessarily match fiscal year financial statements. 4
8 In 2003, Artima began a formal training program for its top managers which requires six managers to take a different MBA course at the local university at a cost of per course. About twice a week, attendees take the material that they have learned in the courses for the week and meet together with the other managers in the course and teach each other what they have learned. Mr. Banu states that teaching while learning at the same time is the best way to ensure that the managers absorb the material and is the most effective way to spread the cost of the training among as many managers as possible. Artima does not fund any manager seeking a full MBA degree, opting instead to offer individual courses to as many managers as possible. In 2003, the total cost of this hybrid formal/informal training for one academic semester was 4320, and it is expected to total 10,000 in projected years. In addition, the development impact analysis factors in a 20 percent premium on skilled employees wages as the retail skills that the employees learn are not present in the local labor market and are therefore highly prized and marketable. To date, however, Artima has lost only three upper managers, one voluntarily due to relocation to Bucharest, and two dismissed due to corruption. Consumer Surplus Artima provides a wider range of choice of products previously unavailable in the local market, and often at a higher (and more consistent) quality. Artima prices its goods at the same level as the current market, maintaining an average gross margin of percent, 2 compared to average margins of more than 25 percent in developed markets. Even when Artima s margins are lowered, such as in Oradea, store prices often remain above local market prices. This is primarily due to the prevailing level of black market competitiveness, as unregistered markets avoid the 19 percent VAT and other taxes, and, due to the cash economy, permitting smaller shops to report lower sales to authorities. It is difficult to measure the effect of quality or wider assortment of goods in an accurate and quantifiable way. It is also not clear how highly consumers currently value quality versus cost due to current household economic conditions. However, it is clear that Artima is providing local consumers with choices as to reliability of product presence and quality, range of selection, and convenience. It is also raising the standards of quality associated with food products, even if doing so may in the short run result in incremental costs to the business. For example, Artima s butchery follows all health and sanitary conditions for meat produce, including daily veterinary inspections which accordingly adds to the total cost of providing meat products. Therefore, Artima is not price competitive on meat products, as the black market does not bear these costs. Artima s meat sales are below expectations and are often a loss-producer when spoilage and price reductions are factored in. Despite what would appear to be definite contributions to consumer welfare, SEAF has not made any quantitative estimate for such factors. It is reasonable to suppose that the surplus values provided by Artima are substantial, given the significant growth in turnover per store over time. Therefore, the total quantified developmental impact for Artima is likely understated. Producers of Complimentary Goods Artima stores have impacts through at least two complementary economic agents, although more that were not captured in the study may exist. These are the security service providers, responsible for instore security at each location, and local construction companies, responsible for the construction of new stores. 2 Total gross margin averages 17 percent due to other income, such as listing and slotting fees. 5
9 Zen Security According to a regional manager, Zen Security is a security services provider with approximately 1000 employees, with a 9-10 percent market share in Northwest Romania. Its employees are generally former sportsmen who have a strong work ethic and now face limited employment opportunities. Each Artima store requires four security agents for each of the two shifts, as well as one supervisor who is usually responsible for two to three stores. Artima signed a services contract with Zen to provide overall security at each store location that is based on a fixed monthly rate, minus the cost of goods for all inventory theft above the targeted 0.74 percent. 3 Inventory theft is monitored through the difference between all goods sold according to the point-of-sale information system, minus adjustments due to spoilage, and the handcount inventory performed daily on a revolving basis throughout the month. The contribution to development impact is based on Artima s security costs, with an assumption that Zen has a 12 percent gross profit margin. An employment effect is added with the (conservative) assumption that 10 percent of Zen s operational costs are due to personnel. Local Construction Providers Artima s construction costs average about 1 million for each new store location. Of this, 50 percent are direct on-site construction costs, and another 30 percent are indirect costs that are required to renovate the location or make other infrastructure improvements that are not necessary for store operations but are required due to obligations in the concession contract with the city. The remaining 20 percent are materials and equipment that are imported. The development impact of these complementary providers is estimated at a 12 percent gross profit margin on the approximately 800,000 in total local construction costs. The employment effect is based on the assumption that 20 percent of these costs are due to labor. While not absolutely necessary, the 30 percent of construction costs that are required as part of the city concessions for the locations are often in interest of both the city and Artima. These costs may be due to road improvements, park development, and renovation of at least part of the commercial center, 4 and are further explained under the section Neighbors/Community Development. Other minimal complementary economic agents that were deemed too minimal to include in the analysis are the costs of employment advertisements in local newspapers and pick-up fees charged by local banks on cash stored on location from operations. More generally, one can see how supermarkets like Artima have important multiplier effects on the local economy. Profits of Local Suppliers Based on Artima s total inventory records, it was only possible to confirm that 1.41 percent of total store revenue is derived by local producers. This figure may be under-reported due to distributors that purchase local goods, but operate on a national scale. Total national suppliers of Romanian goods amount to about 25 percent but are not included in the development impact for conservative reasons. Local producers are generally able to maintain a 25 percent gross profit margin, though informal produce suppliers rarely include the costs of their own labor into the cost of goods. Although the quantifiable impact is minimal, Artima s introduction of bar coding into the local supply chain has had significant, if not quantifiable, effects on local producers. Previously, with informal markets and the non-existence of retail shops managing their operations though an IT system, bar coding was unknown and unnecessary to sell goods in the local market. However, Artima s IT system requires bar coding on all products. To affect this system, Artima has helped local suppliers create their own bar codes 3 Total inventory shrinkage is target at percent. The difference is due to spoilage and returns. 4 This is a multi-storied building in the centre of town that formally sold most of the commercial goods under the planned economy. 6
10 for their products. Although strictly in Artima s commercial interests, the add-on effect has been to open up the nationwide market to local suppliers who are now able to participate in large distribution networks. In addition, the IT system that Artima employs was developed in conjunction with a Romanian software company who has since employed the ERP system in other retail companies as the market grows and as retailers become more sophisticated in Romania. These undoubted benefits are not quantified in the analysis. Competition and New Entrants Despite the many positive influences Artima has on the local economy, it is also clear that Artima has a negative impact on those enterprises or individuals that were previously selling FMCG s in these cities and regions. Artima s success will therefore directly affect existing employment, especially so in the informal markets, although less so in small shops. Artima estimates that a new store takes about percent of the previous market size 5 upon entry to the city, factoring out organic market growth and the market of goods that were previously unavailable. Although no official statistics exist, the estimate is that approximately 100 employees/entrepreneurs in the black market and small shops go out of business when a new Artima store opens. 6 According to interviews with Artima employees who were formerly part of the black market employment pool, the average monthly wage was about 25, and often required 6-7 days of labor per week. Combining these factors, there is an annual negative 30,000 adverse impact per new store on employment in the local economy. As our study of the effect on employment concentrates on the economically inactive versus the unemployed, official statistics are unlikely to support these assumptions. Our analysis is based on assumptions that were derived from interviews with Artima management and staff. The effect on local unofficial employment must also be counterbalanced with the official employment created by the new store. A new store is the largest commercial business in some of the smaller towns, with roughly 50 employees per store and revenues between 1-3 million per store. Based on Artima estimates derived from employment interviews, almost all of their employees at the store level either previously worked unofficially in the same sector, or were economically inactive. With official employment, not only is the minimum salary almost three times their wages earned in the unofficial economy, but employees also join the national health and pension system and receive the other non-salary benefits. Furthermore, Artima only requires that the employees work five days a week. This factor offsets the original negative impact on employment. As previously mentioned, Artima also pays 19 percent VAT and other corporate taxes and fees on the market share they replace. Neighbors/Community Development Artima makes many infrastructure improvements to the cities as part of its concession agreements. In almost every city where Artima has developed a new location, some type of civic concession has been part of the agreement. A table follows below: Store Location (City) Resita Lugoj Deva Sannicolau Carensebes Oradea Civic Improvement per Concession Agreement Refurbishment of central park: e.g., paths and lighting. Expansion of parking facilities in downtown area. Rent. Some renovation to Commercial Center. Minor improvements to main road and main intersection. Rent. Major renovation of bottom floor in Commercial Center. Shared 1/3 of the costs of new park in formally abandoned land space, construction of playground. 5 This figure is a range of the total market share estimated with the black market and official figures. 6 Though registered, small shops are included in this analysis as most employment in the shop is unofficial. 7
11 Bistrita Baia Mare Petrosani Minor infrastructure repairs. Development of abandoned land space, new parking near bus station. Development of abandoned land space for commercial activities, and enhanced traffic patterns. In many cases, whether Artima takes over abandoned land or underdeveloped commercial space, improvements in the land area around the store location improve traffic flow (car and foot) and increase the visibility of the location. For example, the park developed in Oradea around the store was formerly an abandoned pit between high-rise housing developments. This area, which was bypassed by traffic between the surrounding high-rise housing, has been transformed into a large green space and playground that not only enhances the quality of life of nearby residents, but is a gathering and crossing point for residential traffic, which improves store revenue. Improvements to commercial centers revitalize a formerly popular commercial area in the center of the city, which in turn re-energizes the city center. Although not completely commercially necessary for the development of new stores, Artima is willing to absorb these extra costs as part of the agreement for a multi-year concession since these costs improve traffic flow and visibility of the location. These non-quantifiable benefits that the Artima investment brings to the community, including the improved quality of life factor due to infrastructure improvements in the center of the city, increased assortment, and higher quality goods, are not included in the development impact tallies. Other Social Benefits The main other social benefit from Artima s business is the financial contribution to the government and local financial institutions. As detailed in the model, Artima s contribution to the government comes less from profit taxes (for the first few years, Artima has a tax credit due to its losses), but through other contributions such as unreclaimed Value Added Taxes, import taxes, other corporate taxes, contributions to the National Pension Fund, and other social taxes, including excise taxes. While these contributions may be taken for granted in developed economies, Romania only recently was granted the status of a market economy by the US government, and still has not passed the hurdles for the same designation from the European Union. In addition, the government must undertake significant fiscal reform in order to qualify for eventual EU membership. Artima, by replacing the market share of non-tax paying businesses, thus makes substantial contributions to the normalization of Romania s fiscal budget one city at a time. There are also benefits such as financial institutions profits made from loans to Artima, but due to the lack of data, these benefits are not included. One Store s Story: Resita With a population of about 93,000, Resita is the capital of Caras-Severin county (highlighted in the map to the right), located in the southwest region of Banat. Official unemployment in the province is 9.7 percent, higher than the regional average of 8.6 percent and the national average of 8.3 percent. It is difficult to estimate the true status of unemployment due to the dropping out of those who are no longer actively searching, but approximately 40 percent of the population is employed. This is largely due to the closing of many businesses in the iron and steel sector due to the restructuring of the economy and privatization. Resita was the first of the Artima stores to be built with the invested capital of the entrepreneur, Mr. Banu, as well as the know-how value received from an Austrian colleague who is a director of another supermarket chain in Eastern Europe. Although unemployment is high, several factors influenced the decision to build the store in Resita: the location that city authorities offered Artima was in the center of the city, the immediate catchment area is the densest of the city and, in Artima s judgment, could support 8